FOMC Minutes and Thoughts on Forward Guidance

Marc To Market's picture

As high income economies improve and the financial sectors stabilize, central bankers understandably and rightly, want to move away from the unorthodox policies that were necessary to avoid an even larger collapse and more suffering.  At the same time, they want to reassure investors, businesses and households that they do not intend on increasing interest rates any time soon.  The process by which central banks do this has been dubbed forward guidance.


Initially, as the Bank of Canada Governor, Carney used a date approach.  This approach was eschewed by the Bank of England and the Federal Reserve for more a more data specific approach.  Both central banks picked an unemployment rate, 7.0% and 6.5% respectively.  To varying degrees, both central banks noted, for anyone who wanted to listen, that these were thresholds for which policy would be re-examined, not triggers a for a change in policy.  


Both of the thresholds are being approached, dare one say before most observers, including those at the central banks expected.  The substance of forward guidance must evolve with economic conditions. Those who argued that the Carney would ditch forward guidance confuse the communication mechanism with its substance.  The FOMC minutes for last month's meeting show that US officials are also wrestling with the evolution of its forward guidance.  


There seems to be a finite number of possible tactics.  Officials could, for example, simply lower the current thresholds.  This, however, may undermine the credibility of forward guidance.   Another alternative could be to adopt a more qualitative approach.  This is what the BOE seems to be doing.  


A third possible course for the Federal Reserve is to emphasize its third mandate:  financial stability.   The problem with this is that if financial stability was threatened the Fed would more likely have to be accommodative than restrictive.   A fourth option would be to adopt a different threshold, to wit:  The FOMC does not anticipate the need to increase interest rates while the core PCE deflator is below, say 1.7% (it stood at 1.2% at the end of last year).   The fifth option is to find a different channel to communicate one's intention.  The Federal Reserve can make it point, for example, through its quarterly interest rate forecasts.   


No doubt with some many business people and economists and various interests and sensibilities represented, there are bound to be advocates of each course.  Judging from the January FOMC meeting, it is not clear the Fed has decided yet.    Put in a larger context, we suspect the Fed will opt for the more qualitative approach and placing more emphasis on signaling function of its interest rate forecasts. 


In some ways, though, this evolution of the forward guidance communication style is largely a question of adaptation not speciation.  This is also an important take away from the FOMC minutes.  Not only did Bernanke put the Fed on the tapering path, but also raised the cost of deviating from that path.  


Even before the minutes, it seemed clear to us, that the bar to stop tapering or speed it up (which seems somewhat less relevant now in the face of the dramatic slowing of the US economy to something probably around 1.5% annualized, based on the current information set and conservative projections) is set high.   The minutes reinforce this sense.  


The key though is not how the economy does.  Rather it is what the economy does relative to the Fed's outlook.  The minutes make clear that last month, officials recognized that the pace of the economy in H2 were due to temporary factors that would likely be reversed in the H1 2014.  This means that there should be little doubt that the Fed continues to taper.  Forward guidance is the communication style to manage expectations.  Tapering, that is policy.  

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
ptolemy_newit's picture

thank you Boris.

I am learning from your post, but will not comingle anymore :)


Carl LaFong's picture

What will happen to tapering when their H1 forward guidance proves to be wrong (yet again) and the only major buyers of UST are the FED and the Sheeple who will be forced to buy them for the "safetey" of their retirement? 

TheRideNeverEnds's picture

Just close your eyes and buy the dip; DOW 36,000 or bust! 

i_fly_me's picture

Brussels can only buy so much... the tapering is gonna taper.

Crazed Smoker's picture

History is the best indicator of forward policy.   If and when the economy runs into slowdown they gonna priiiiiiint!!

Boris Alatovkrap's picture

Boris is run FOMC minute through Google Translate...

"Print Moar money, ZIRP is forever to stay, buy US stock!"

ptolemy_newit's picture

Boris seeing not the picture enough big!

It currency and economic and political and religious war. US foreign policy start fire in countries many these years what for you can ask? Scared little country of other empire to take shape.     Middle East empire could big Islam hate interest on money loan so jrewish would be like crazy against competition for money loaning skimming middlemen.

Euroconflictunity only 12 countries must be and club med no holiday because poor hair north people get the stickler. So ussa need euro at 1.5.

The new money comes from the coldest places before and after the tropic lines.  We think like Siberian Aduu to mate with slimmer women of east.  New word for this empire growing is CRAMSTAN – China, Russia and Mongolia with many stans.

So pump and dump of commodities necessary would be by last stand of culling the peak problem of people.  USSA ferrel bank has new orders to crash system after C of CRAMSTAN get big full of spending money on things that are raw.


Sure time they take to arrange tracer currency new that has no paper needed.

Doña K's picture

FED is notorious in playing word and number games. If you really think about it the message they are sending is multiprong but can be explained simply:

"We will do what is necessary, when we feel it is necessary and will re-evaluate when necessary. And who are you to question us? We are owned by the TBTF banks and they also own Congress and the O'clown 




Boris Alatovkrap's picture

You are translate better than is Boris. 10+